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Monthly Archives: July 2019

§5.87 — Bitcoin opens a
new monetary epoch, beyond Macro. Macro persists, henceforth, as a stubborn
archaism. The macroeconomic monetary types (M0…MΩ) are undergoing
replacement – immediate in principle and incremental in practice – by
cryptocurrency coinages. Bitcoin does not restart this displaced series at M0,
but somewhere in the middle, characterized by intermediate liquidity. In the
direction of superior liquidity, experiments are oriented to lowering
transactional friction, and increasing scale. Money is narrowed insofar as it becomes more conveniently cash-like, though
with lower quality as a store of value. These phases of the spectrum are
inhabited by stablecoins, large block-sizes, and dedicated payment protocols. In
the other, broader direction, of
higher viscosity, the orientation is towards monetary scope, which is to say ever wider asset classes, and – most
significantly – smart contracts. In these – much vaster – phases of the
spectrum, blockchain development can seem to be almost entirely disconnected
from money production, involving ‘coins’ no less exotic than the particles of
high-energy physics. It is worth briefly examining each of these ranges in turn,
to glimpse what money is becoming.

§5.871 — Narrowing our attention, in the monetary
sense, is re-visiting the block-size debate.[1]
In this regard, as more generally, scalability is the avatar of liquidity. The
Mainstreamers seek, as rapidly as possible, to take Bitcoin towards M0. They
interpret strictly constrained block-sizes as an obstruction to this
development. Failing in their attempt to overcome Ultra resistance and direct
Bitcoin down the monetary spectrum, the Mainstreamer agenda found its vehicle
in a hard fork, which split off Bitcoin Cash (BCH) in 2017. The subsequent
market verdict tends to strongly vindicate the Ultra position.[2]

§5.8711 — An alternative to
block-size relaxation is tiering. Rather
than shifting the Bitcoin blockchain down the monetary spectrum (through
block-size relaxation), or splitting the chain, tiering supplements the chain
with a dedicated payment facility. Payment processing takes place predominantly
off-chain. The block-chain is invoked only as an arbitrator, securing
transactions virtually. This is analogous to the way potential legal remedy
secures contracts.[3] This is
the approach taken by Lightning Network, and supported by the BIP141 SegWit
soft fork.[4]
It is – at a minimum – indicative of the direction in which the scaling of
Bitcoin will proceed. Smart contracts, such as those anchoring Lightning
Network transactions to the Bitcoin block-chain, are the essential building
blocks.

§5.872 — Broadening attention enters far more extensive and variegated monetary territories. Once the threshold into cryptocurrency is crossed, the
computerization of money quickly proves irreducible to moving money between computers. Rather, money as such becomes
demonstrably computational. This is to say, computational capability is
increasingly subsumed into money. A
new world of intelligent assets gradually emerges.

§5.8721 — The tendency of
cryptocurrency development, no less than that of the Macro regime it
incrementally displaces, is to liquidate all firm distinction between contracts and currency transactions (or currency as such). This is demonstrated
by prevailing usage of the ‘-coin’ suffix, which references an origin in
decentralized digital currency, but applies to the entire commercium of trustless, P2P deal-making. Anything that can be firmly committed to provides the
potential content for a blockchained X-coin system. Reciprocally, definite
commitments, in general, acquire explicit monetary characteristics.

§5.87211 — The implicit
content of any commercial transaction is exposed to formalization and technical
modification as a smart contract. Conditionalities
are spelt out specifically, and practically, in software. Terms become code. A
smart contract is defined by Szabo as “a set of promises, specified in digital
form, including protocols within which the parties perform on these promises”. They
are digital upgrades of evolved formal relationships which have been
‘techno-hardened’ in a double sense. Firstly, their formalization has been
bound to – and incarnated within – the operations of specific physical
mechanisms (Szabo’s list of precursor technologies includes vending machines,
POS terminals, and bank payment clearing systems). Secondly, and relatedly,
they pose a technological obstacle to breach of contract. They are
comparatively mechanized, and trustless. In game theoretical terms,
they do not offer a defect option – or opportunity to ‘cheat’ – but rather preclude
it originarily. They are complex hard commitments. Any settlement negotiations
have been concluded a priori. The guiding
principle, as he argues, is that “the formalizations of our relationships – especially
contracts – provide[s] the blueprint for ideal security.”[5]

§5.87212 — Szabo differentiates reactive from proactive approaches to security. The distinction separates those systems that involve punishment and restitution from those that obviate them. The former are far more closely bound to the intervention of ‘trusted third parties’. It is the latter category that converges with the smart contract. Smart contracts are intrinsically resistant to violation. Vending machines are an illustrative prototype. The historical progression leads “from a crude security system to a reified contract” whose terms are substantially self-policing. Since anything which can be the object of a business deal can be – in principle – covered by a smart contract, the field under consideration is no smaller than that of property in general. It shares the same horizon, in other words, with money at its maximally illiquid extension.

§5.87213 — The potential of smart contracts to facilitate criminal activities has understandably triggered some concern.[6] In particular, it provides the capabilities required for the long-dreaded ‘assassination market’ anticipated by Jim Bell in the mid-‘90s.[7] A ‘contract’ could – with remarkable smoothness – take on the sense this term bears within the organized criminal underworld, among others. The privatization of justice can look rough. This too is not only something money could do, but potentially part of something that money is.

[2] The splitting of Bitcoin Cash (BCH) from Bitcoin (BTC) maps very
neatly onto the money spectrum. The cryptocurrencies were divided by a hard
fork, which occurred on August 1, 2017. Bitcoin Cash blocks were increased in
size to 8MB (from Bitcoin’s 1MB). In mid-2019, Bitcoin Cash was trading at a
value less than a thirtieth of Bitcoin’s. A technical potential for superior liquidity realizes neither liquidity nor
scale without broadly-based market endorsement. A subsequent hard fork, on
November 16, 2018, divided Bitcoin Cash from Bitcoin SV (BSV), with ‘SV’
standing for Satoshi Vision.
Cryptocurrency investors have yet to be persuaded. The market cap of Bitcoin SV
settled at roughly half that of Bitcoin Cash.

[3] “Transactions can be made off-chain with confidence of
on-blockchain enforceability. This is similar to how one makes many legal
contracts with others, but one does not go to court every time a contract is
made.”

[4] Securing Lightning Network transactions required an upgrade to
the Bitcoin protocol. Specifically, the integrity of the new off-chain layer
required a correction to ‘transaction malleability’ on Layer-1. This was
effected by the Segregated Witness (SegWit) soft fork (BIP 141), activated on
August 24, 2017. SegWit adjusts the way signatures are registered on the
blockchain. The Lightning Network is built out of bidirectional payment
channels, which reticulate in an open-ended system. The integration of two
nodes into a channel establishes a smart contract. Opening a channel requires a
‘funding transaction’ which is registered on the blockchain, but subsequent
payments remain off-chain, unless a dispute arises, or until the channel is
closed. The Layer-2 system is thus anchored on the blockchain, as arbiter, but
one only rarely invoked. The security of the main Bitcoin blockchain is
leveraged economically. Since late spring 2018, the network has been growing
exponentially from a low base, with a doubling period of roughly five months. It
is envisaged as a complete decentralized substitute for the banking system,
connecting all financial agencies down to the level of individuals – and even
below – as nodes.

Joseph Poon and Thaddeus Dryja published the Lightning white
paper in 2016. It can be found online at: https://lightning.network/lightning-network-paper.pdf

[7] The concept is outlined in Bell’s short, incandescently
brilliant, and almost peerlessly ‘edgy’ essay ‘Assassination Politics’. … The
upsetting features of assassination politics flow without exception from the
full-spectrum subsumption of social coercion into the market. State monopolization
of violence is subverted by a distributed auction. … https://web.archive.org/web/20041209151654/http://jya.com/ap.htm

§5.863 — The final
ingredient in the suite of soft technological advances that are drawn together
in the initiation of cryptocurrency simultaneously resolves the Byzantine
coordination conundrum and secures monetary tokens against duplicitous
proliferation. It thus integrates the seemingly disparate challenges of
decentralization and deflation. To repeat the point with reverse emphasis, it
protects a decentralized monetary system against the twin threats of coalescence
(into the enemy ‘city’) and inflationary devaluation. It has, in both aspects,
to fully substitute for the function of pseudo-transcendent trusted authority. This
requires a production of immanent or
intrinsic credibility. The computer science solution was found in
proof-of-work.

§5.8631 — Proof-of-work
dates back to the final years of the last millennium. The critical step was
taken by Adam Back[1] in his
proposed ‘counter-measure’ to the exploding Internet spam problem.[2]
Proof-of-work credentials could be used to indicate the seriousness – or
non-frivolity – of a message. By demonstrating that trouble has been taken, they recommend attention. In the case of
the Byzantine generals, they separate committed communications from glib
deceptions, without recourse to extrinsic validation. In the case of monetary
accounting, they preclude cheap forgeries, and thus eliminate every normal
incentive to forge.

§5.86311 — Back quickly
realized that proof-of-work credentials (or cost
tokens) were intrinsically money-like. “We use the term mint for the
cost-function because of the analogy between creating cost tokens and minting
physical money,” he notes.[3]
They were both earned, and valuable. In fact, all six of the essential monetary
qualities could be attributed to them. This insight was formalized – as hashcash
– in 1997.[4]
Back described hashcash as a ‘denial-of-service counter-measure’, although its
potential applications were far wider.

§5.8632 — A cost-function
is time-like, or asymmetric. It has the synthetic a priori characteristic, essential to cryptography, of being
difficult to discover but easy to check. Back states that it “should be
efficiently verifiable, but parameterisably expensive to compute.” The
combination defines (valid) work. Concretely,
work measures applied computational power. It has the game-theoretic meaning of
commitment. While deterministic
cost-functions are possible, those adopted by hashcash and subsequently Bitcoin
are probabilistic, producing tokens based on the performance tested set by particularly
arduous (trial-and-error) exercises, precluding short-cuts.[5]

§5.86321 — Among the practical concepts introduced into monetary history by proof-of-work, perhaps the most important is difficulty. Several points are worth noting explicitly. Firstly, the asymmetry in the difficulty of production relative to checking is so massive that the latter is treated as of negligible difficulty. This comparatively informal side-concept then contributes precision to the idea of convenience. Secondly, and of greater technical consequence, difficulty – while probabilistic – can be exactly quantified. In this second critical asymmetry, the problems posed as proof-of-work tests are fully understood even while completely unsolved. They can not only be finely determined, but also set, and adjusted. This makes difficulty a technical variable. In cryptocurrency, it substitutes for all macroeconomic controls.

§5.86322 — Hashcash catalyzed a theoretical breakthrough in cryptocurrency-oriented computer science during the final years of the last century. Most notable were two sophisticated proposals published in 1998, Wei Dai’s B-Money and Nick Szabo’s Bit Gold. Both were conceived as decentralized money systems based on a proof-of-work function. Compared to Bitcoin, neither proposal was fully realized.[6] Neither, in any case, was implemented. Proof-of-work had, however, securely established itself in principle as the foundation upon which money would come to rest.

[1] In a 2002 retrospective on hashcash, Adam Back refers to earlier
work by Dwork and Naor who had already “proposed a CPU pricing function for the
application of combating junk email.”

[2] ‘Spam’ is used here in an expansive sense. It encompasses the
primary explicit object of Back’s concern, which is the Sybil attack. A Sybil attack ‘spams’ online identities, rather than
advertising messages, in order to overwhelm systems with voting procedures
(which would include pre-proof-of-work consensus mechanisms). The term ‘Sybil
attack’ is much younger than spam. It seems to have been coined in 2002 (or
earlier) by Microsoft researcher Brian Zill. The term took its name from the
book Sybil, a case study in
dissociative identity disorder.

[3] For this and subsequent Back quotes, see: http://www.hashcash.org/hashcash.pdf

[4] Of the critical computer science components required for the
Bitcoin protocol, proof-of-work was the latest to become available.
Cryptocurrency predecessors B-money (Wei Dai) and Bit Gold (Nick Szabo) were
both formulated in 1998, less than two years after hashcash was introduced.
That Bitcoin did not arrive for another decade might, then, be considered a
puzzle of interest. It suggests, at least, that momentum in software
development is easily over-estimated. It is also possible that the PC hardware and
Internet infrastructure conditions for Bitcoin ignition were not earlier in
place. Perhaps an accelerated arrival of Bitcoin, even if conceptually mature,
would have been practically premature. Additionally, regarding supportive
conditions, the socio-cultural context of the 2008 financial crisis and
resultant mass disillusionment with central bank monetary competence is
suggestive. In the final years of the new millennium’s first decade, the case
for an escape from macroeconomically-managed money made itself. It awaited only
cogent formulation.

[5] “The hashcash CPU
cost-function computes a token which can be used as a proof-of-work,” Back
explains. This cost-function “is based on finding partial hash collisions on
the all 0 bits k-bit string 0k,” as would also be adopted
later by Bitcoin.

[6] B-Money remained dependent upon third parties for dispute
resolution, while Bit Gold did not employ proof-of-work for Byzantine consensus
(but only as generator of value) leaving it vulnerable to Sybil attacks. It is difficult
to note these deficiencies without recognizing the economical genius of the
Bitcoin synthesis. With Bitcoin it was for the first time shown what proof-of-work could do.

§5.862 — Under even modest
techno-historical scrutiny, cryptocurrency divides within itself, or doubles.
Beside the major topic of money-production is revealed a minor (and
inward-turned) twin. Cryptocurrency has its own – additional – use for money,
which is to say for itself, intrinsic to its possibility. It folds upon itself
essentially. While making money – in multiple senses – it also makes of money a new, specific machine-part. There
are things it needs doing which will not be done unless rewarded. Thus the
initial return on the issuance of money – seigniorage
– is allocated by Bitcoin to the maintenance of its own decentralization.[1]

§5.8621 — Only by way of
money in its minor sense – i.e. as the mining compensation token – does money
in its major sense undergo practical redefinition as an automatically self-sustaining decentralized system. The path of
money production is shaped by the protocol in such a way as to spontaneously
reinforce those user behaviors the system depends upon. So tightly is this incentive
mechanism constructed that all bitcoins originally reward Bitcoin maintenance,
while also stripping Bitcoin maintenance of discretion, by integrating it
rigorously into the process of mining. There is nothing a bitcoin miner can do to sustain Bitcoin beside mining
bitcoins. Sheer industrial effort, alone, is rewarded, and that has been made
enough.

§5.8622 — It is
particularly important to note that bitcoin mining rewards make no payment for
loyalty, as compensation for non-defection. The miner is not in any respect a trusted official. The relation between
money and trust has been fundamentally re-ordered. It is rather, now, that the
miner makes bitcoins trustworthy through an activity which demands no trust
whatsoever. The historical passage, as previously remarked, is from the
consumption of trust to its production. §5.8623 — Currency
units denominate incentives. There is nothing notably novel in this insight.
Making incentive engineering inherent
to currency production, however, proved a decisive technological break. Bitcoin
initiates the epoch of cryptocurrency, strictly speaking, by structuring its
protocol as a game. This is the sense the token
now carries. Besides providing money, it directs those behaviors specifically
required for its social implementation. The positive cybernetic loop here is
conspicuous, and remarkably ingenious. The value of money is made a function of
its own operation, as a directive force. The more bitcoins are worth, the more
they engender an industry which builds Bitcoin.[2]

[1] It might be asked: Was it
not always necessary to pay gold-miners – or at least for gold-mining – as also
for work in the mint, or the central bank? Did not money, then, always involve
a minor internal digression or auto-productive reflex? What is really new here?
Raising this question is potentially informative, since it tends to isolate
the cryptocurrency innovation. The incentive system at work in Bitcoin
substitutes for monetary authorities. The only forerunner is to be found in
primary precious-metal production, in which – crucially – the miner is rewarded
immediately and automatically for industrial activity. Neither work contract
nor marketing is necessary. Mining, of this kind, produces money. In the case of Bitcoin, all money – without
exception – is mined, originating as property of the miner. Bitcoin is not,
however, reducible to simulated gold. Bitcoin mining, unlike its concrete
precious-metal predecessor, is also, simultaneously, minting, or monetary
validation. A functional analog of the assay is built into the mining process,
integrally. Its cycle produces trust, rather than drawing upon it. What makes
it good money is made part of the way it makes money. This seamless loop is its
essential innovation, synonymous with what cryptocurrency
means.

[2] In the electronic wholesale markets of Shenzhen, cryptocurrency
mining rigs have been added to the range of commodities on offer, alongside
such comparatively recent product lines as vaping devices and drones. Here the
power of incentives is starkly illustrated. This outcome was – of course –
entirely unanticipated by the Bitcoin white-paper, which assumed general
purpose personal computers (rather than dedicated ASICs) would be the engines
of cryptocurrency mining, perhaps in perpetuity.